China’s Military Spending A Defense Against Slowdown

By

Wayne Arnold

Updated March 5, 2015 10:28 p.m. ET

Order Reprints

Print Article

Chinese President Xi Jinping shakes hands with crew members of air force during his inspection of the armed forces in Xi’an, northwest China’s Shaanxi Province, Feb. 16, 2015
Source: Ministry of Defence The People’s Republic of China. (photo Xinhua/Li Gang)

Text size

Everything about China is getting bigger, so why not its military?

As they plotted a course this week for a gentler economic course, slashing their target for GDP growth and inflation, China’s leaders unveiled plans to boost military spending by 10.1%.

That will doubtless cause hand-wringing in capitals around Asia and in Washington, where China’s more assertive posture in the region is raising hackles. But China’s military expenditure, as it is fond of pointing out, remains a mere fraction of what the United States spends annually, and is lower both relative to the size of its economy, and on a per-capita basis.

China’s critics say Beijing’s official defense budgets fail to capture about half of its actual military spending. Other parts of the non-defense budget often end up funding the military and the budget doesn’t count investment funded by the People’s Liberation Army’s own businesses. Yet even once estimates of these additional expenditures are included, China still spends relatively less, according to the Stockholm International Peace Research Institute.

Nevertheless, China’s population and economy are so large that even proportionally small increases in spending are having an outsized impact on regional security. China has already laid claim to contested islets in the East China Sea and pretty much the entire South China Sea, sparking maritime confrontations with Japan, the Philippines and Vietnam.

China now has an aircraft carrier that gives its navy the ability to project air power far beyond China’s shores. It has developed a fighter jet, the J-31, that some experts worry can outmaneuver the new F-35 still being rolled out to air forces in the U.S. and its allies in Japan, South Korea and Australia. A U.S. admiral told American lawmakers last month that China now has more submarines than the U.S., too.

China’s military rise has already sparked a regional arms race. India, which has spats with China over their Himalayan border and is nervous about China’s rising naval presence in neighboring Sri Lanka, just boosted its own military budget by 11% to nearly 2.47 trillion rupees ($39.6 billion).

And Japanese Prime Minister Shinzo Abe, as this column has noted, has used China as a pretext to end a long freeze on military budget increases, lift a ban on military exports and allow greater participation by Japan’s military in operations with its allies abroad. In January, Abe’s Cabinet approved a 2% increase in Japan’s military budget to a record-high 4.98 trillion yen ($41.5 billion).

The growing risk of mutually assured destruction aside, expanding military investment is an excellent way to boost fiscal spending and support China’s slowing economic growth, as Barron’s has previously noted. Such investments push money into the economy without worsening overcapacity in infrastructure. And unlike other government procurement that can be sourced overseas, security concerns dictate that nations be at least somewhat self-sufficient when it comes to their armaments.

Other than battening down their hatches, therefore, investors are left with little choice but to try to get in on Asia’s rising bucks for the bang. In Japan, as this column has noted before, the difficulty is that most Japanese defense contractors are diversified conglomerates and so buying their stocks doesn’t provide a direct way to bet on Japan’s re-armament.

China’s largest defense contractors are state-owned behemoths like Norinco that aren’t listed. But they do control an armada of contractors and sub-contractors that are. The good people at the China Securities Index Co., makers of the CSI300, have constructed a China Aviation Industry Aerospace Defense Index to track the performance of these 44 defense-related stocks. It has climbed about 4.9% in the past month, better than the roughly 2.3% rise by the broader Shanghai composite index.

Which are the best individual defense stocks? Three top the list: Guizhou Space Appliance (002025.CN) is a unit of giant missile manufacturer China Aerospace Science & Industry Corp. and is involved in China’s space program. It’s trading at 35 times estimated earnings for fiscal 2014, according to Bloomberg, higher than its historical average, but offers one of the highest dividends – 0.9% -- in a sector that pays almost none.

Then there’s China Aviation Optical-Electrical Technology (002179.CN), better known as Jonhon. Jonhon was the first military enterprise in China to go public and has the distinction of having one of the lowest debt levels in the sector and one of its lowest valuations, trading at just 39 times projected earnings.

At the top of the heap, though, is Sichuan Haite High-Tech Co. (002023.CN), which among other things makes flight simulators for pilots military and commercial. With low debt and one of the sector’s highest rates of earnings growth, it’s trading at a discount to its historical price-earnings ratio. As China looks to boost its air power and fill its fighters with fighter pilots, Sichuan Haite’s shares could be poised to soar higher.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.